Tesla plans US$1.5b bond market debut to fund Model 3

[NEW YORK] Having tapped the equity market eight times for capital over the past seven years to fund Tesla Inc's growth - and cover its losses - Elon Musk is turning to the bond market.

Needing cash to finance his audacious bet on the mass production of a more affordable electric car, the Model 3, Musk plans to sell US$1.5 billion of eight-year bonds. Tesla officials are meeting with investors across the US this week to drum up demand. The debt sale will test Mr Musk's ability replicate the fervent following he's built among stock investors, who've bought into his vision of a clean-energy future and pushed the shares up 67 per cent this year.

While bond markets have been running at historically frothy levels, Tesla is asking potential noteholders to overlook the company's negative cash flow and its repeated trips to capital markets to bolster its balance sheet.

This would be the company's first sale of non-convertible bonds, according to data compiled by Bloomberg. During early conversations with investors, Tesla has been offering to pay around 5 per cent on the notes, according to two people with knowledge of the matter, who asked not to be identified as the discussions are private. That lines up with the 5.4 percent investors are demanding for junk-rated companies, according to Bloomberg Barclays index data.

Prospective buyers of this deal are investing in a company that has long had negative cash flow, and unlike with convertible securities, they won't enjoy many gains if Tesla is successful. The convertibles give holders a chance to profit if Tesla succeeds, by letting them transform the bonds into stock if the shares rise enough.

"As a straight bond investor, it's hard for me to think I really want to do this," said Jack Flaherty, a money manager at GAM Holding AG who previously bought Tesla convertible debt. "It's not like we're getting 10 per cent to fund a negative-cash-flow company," said Mr Flaherty, who hasn't decided if he'll participate.

Moody's Investors Service is rating the bonds B3 - six steps below investment grade - with a stable outlook. While Tesla's brand name, products and facilities could be valuable to companies like Apple Inc and Alphabet Inc, the car producer faces significant risks as it attempts to boost production of the Model 3, Moody's analyst Bruce Clark said. Those include the rapid start of production for a totally new vehicle and the rush by existing automakers to introduce their own electric cars.

"They've got a lot of momentum from the standpoint of interest in the vehicle, but harvesting all of that - getting production levels up to where they want them and doing it in a glitch-free manner - that is not easy," Mr Clark said in an interview.

The US$35,000 Model 3 is the linchpin of Musk's plans to turn Tesla into more of a mass-market manufacturer. With a starting price roughly half the cost of the base Model S, the smaller sedan has racked up almost half a million net reservations since the company began taking refundable deposits last year. The carmaker plans to make 500,000 vehicles in 2018 and a million in 2020. The company produced almost 84,000 cars and sport utility vehicles last year.

Investor enthusiasm has catapulted Tesla's market value past General Motors Co and Ford Motor Co, but bringing out the Model 3 has been costly. Tesla burned through a record US$1.16 billion in cash in the second quarter, driven by spending on production capacity for the car and batteries.

Mr Musk said on a quarterly earnings conference call last week that the company was considering raising debt rather than equity. Tesla has been able to negotiate favorable payment terms with suppliers to the Model 3, which should help improve cash flow.

"The Nirvana is that we can make the car and get paid for the car before we have to pay our suppliers, which then the faster you grow, the faster your cash position grows," Mr Musk said Wednesday. "Obviously, that's like the promised land right there." The bond sale is the latest in a series of moves Tesla made to pad its coffers this year. The company raised about US$1.4 billion in March through a stock and debt offering and in June expanded credit agreements by a combined US$800 million. Those credit agreements are senior to the bonds Tesla is now selling.

Tesla ended the second quarter with a little more than US$3 billion in cash, the lowest on hand in more than a year. The carmaker said last week it expects about US$2 billion in capital expenditures in the second half of the year as it spends on Model 3 equipment, its battery gigafactory and the expansion of its supercharger network.

BLOOMBERG